Bookkeeping Basics
Content
Bookkeeping Basics In each area of life, techniques are developed and inventions made to answer the problems that arise therein. Thus, for example, the invention of the "airplane" provided an answer to the problem of reducing travel time between distant cities. The discovery of "canned foods" on the other hand gave an answer to the need to keep food fresh for long periods. This is similar to what happened with bookkeeping, in that it answered the severe problems that arose in managing modern commerce. It is important to remember that we are in fact talking in a new language that you have yet to learn, as you had to learn any foreign language when young. Before we go into the structure of the language, we will try to see which problems are answered by bookkeeping. 1. The problem of human memory - In a commercial business, even in the smallest business, hundreds and thousands of transactions are carried out over a year. It is obvious that without proper records, it would be difficult for you to reconstruct past transactions relying on your memory alone. 2. Determining the annual profit - Determining the precise annual profit is of the utmost importance, both to you as the owner of the business and to the Tax Authorities (Income Tax, V.A.T. and Social Security). Bookkeeping is in fact the raw material used as a basis for determining the profit. 3. Current Control - By means of up-to-date bookkeeping, it is possible to obtain current data in real time. Thus for example, you are able to use bookkeeping to obtain answers to questions of the sort: 'What is the cash balance?' 'What is the balance at the bank?' 'What credit is available to any particular supplier?', and more. 4. Business analysis - It is reasonable to assume that you will ask yourself how to increase the profits of the business. Is it possible to reduce any particular class of expense and so on It is obvious that the main tool to assist you in an analysis of this type, is the bookkeeping system. We will go on to the technical part which is, in fact, the structure of the language known as "bookkeeping". As with any other language, this stage resembles learning the alphabet and basic rules of grammar and it is, naturally enough, fairly boring. Try not to skip this stage as it is actually the basis for bookkeeping language.
BOOKKEEPING CONVENTIONS Bookkeeping language is based on 2 basic conventions: 1. The Convention of the Common Monetary Denominator
Try to add the following two data: Let us assume that you are deal in textiles. On the 15th of the month, you bought 13 kilogram of fabric and 17 meters of material.
It is clear that adding the 2 numbers (13 and 17) amounts to 30 but it lacks all significance as the base is different (a kilogram - a unit of weight as compared to a meter - a unit of length). However, if we add the following data to the example, we will reach a logical result. Let us assume that the material is $ 1,000 a kilo or $ 50 a meter, you can state in monetary terms that you bought goods with a value of $13,850/(13 x $ 1000 = $ 13,000 plus 17 x $ 50 = $ 850, Total $ 13,850) It is clear, therefore, that the common basis for every bookkeeping record is the monetary value. 2. The "Dual Aspect" Convention. This convention is in fact at the very heart of a bookkeeping system. Let us take an example of an economic transaction done in the Middle Ages. Jo brings a kg. of fish to the market and in exchange he buys a pair of shoes from Jake. Each of the parties to the transaction "received" a certain economic value and "gave" an identical value. Jo - "received": a pair of shoes and "gave" a kilo of fish Jake - "received" a kilo of fish and "gave" a pair of shoes
3. At this stage, you are of course wondering why we have taken an example from the Middle Ages for commercial life in the 21st century. I am sorry to disappoint you but the situation is very similar today.
Let's alter the previous example to suit our times. Let's assume that Jo buys a
pair of shows from Jake for $ 80. We can see here as well that although we are concerned with a single commercial transaction (from Jo's point of view buying shoes for cash, from Jake's point of view - selling shoes for cash). We are still left with the "dual aspect" convention as follows: Jo - "received" goods (shoes) and "gave" money Jake - "received" money and "gave" goods (shoes)
4. In other words, the language of bookkeeping tends to record a single transaction in dual manner. Once, what the tradesman "received", and the second time, what that same trader "gave". In bookkeeping, each single" commercial The Double Entry Convention transaction is recorded twice. On the "Received" side and then again on the "Gave" side
1. DIVIDING THE TRANSACTION INTO SUBSIDIARY COMPONENTS Bookkeeping Does not refer to a business as a single unit but as a body that contains a number of subsidiary units with a particular person being responsible for each subsidiary unit.
In order to organize the business activities, we will take a separate sheet of paper that will organize all the activities that are connected to the person in charge.
So for example, the Cash Page - will describe everything connected with the cashier, the Goods Page - will describe everything that is connected with the warehouseman, while the Bank Page - will coordinate all that is connected with the person that deals with the banks.
Event 1 - We bought goods for $100 cash. Event 2 - We transferred $60 in cash to our bank account. Event 3 - We bought goods from a supplier for $30 that we took out of cash.
The bookkeeping records are as follows: Event 1: Goods Page Received Warehouseman Gave Cash Page Cashier Gave
Received
100 (1)
100 (1)
The explanation is very simple: The Goods Page - that describes the events from the point of view of the warehouseman - received an economic value of $ 100. The Cash Page - that describes the event from the point of view of the cashier - gave $ 100. Comment - The decision that the left side of the page reflects "Received" while the right side shows "Gave" has no logical explanation and it is a convention adopted for the sake of uniformity only (rather like the rule that all vehicles travel in the right lane on the roads in most countries, a safety regulation that affects everyone in principle (uniformity).
Further Comment: The professional expression for each bookkeeping page is not the "Goods Page" and/or the "Cash Page" but ACCOUNT (as distinct from an account submitted to a supplier for goods or services he :gave" or a tax invoice), somewhat similar to the expression "Report".
From this stage on, we will use the expressions "Goods Account" and Cash Account" and so on. Event 2: Let's sketch "Accounts" (pages). It is obvious that the relevant accounts are: the "Bank Account that describes what happened in the transaction from the point of view of the person in charge of the account with the bank and the "Bank Account". The record will look as follows: Goods Page Received Warehouseman Gave Cash Page Cashier Gave
Received
60 (2)
60 (2)
Event 3: The record will look like this: Goods Page Received Warehouseman Gave Cash Page Cashier Gave
Received
30 (3)
30 (3)
In actual practice, the account looks somewhat different. The three sides are removed from the original account and the resulting format resembles the letter 'T'. In fact, the custom is to call accounts by the name 'T Accounts'.
Bookkeeping Course: TYPES OF ACCOUNTS 1. PERSONAL ACCOUNT - Any account that bears the name of a particular person (including, of course, names of companies, suppliers, customers and so forth). For instance, the Walters Account, the Mortimer Account, the Calvin Motors Ltd. Account, and more. 2. REAL ACCOUNT - Any account for which that recorded on the account can be really verified. For instance, the Cash Account (if the Cash Account shows that we received $ 80, then we can check physically to see if we have $ 80 in cash). Another example is the Goods Account. If the Account shows that we received goods worth $ 100, then goods to that value should be physically present in the warehouse. 3. PROFIT AND LOSS ACCOUNT- Any account that describes an expense or receipts (the name of the account will always be followed by the words ' ... Expense Account' or '... Receipts Account'}.
Until now we have learned that the left hand side of the account is called 'Received' and the right hand side is called 'Gave'. The correct expressions that are used in the profession are: The left hand side (the 'Received' side)- the Debit Side. The right hand side (the 'Gave' side)- the Credit Side. Moreover, there are clear rules as to when to debit the account (that is to say, to enter the record on the left hand side) and when to credit the account (that is to say,
to enter the record in the right hand side). We shall use the following tables and the example that follows it to help us understand more fully: THE DEBIT AND CREDIT RULES Type Account of
To Debit the Account When the person whose
To Credit the Account
1. Personal
in
whose
name
the
When
the
person
in
account is kept is in debt to us When the account money/the
whose name the account is kept is in credit with us
2. Real
received equivalent
When the account gives us money/the equivalent
3.
Profit and Loss
Any account that ends Any account that ends with the words 'Expense with the words 'Revenue Accounts'. Account'
Comprehensive Example: 1. 1.1.xx We bought goods from Waterman for an overall sum of $ 1,000 (Invoice No. 123).
2. 2.1.xx We sold part of the goods for $ 600 cash (Receipt No. 1950) 3. 3.1.xx We paid $ 200 cash for electricity expenses (Expense Voucher 001). 4. 4.1.xx We bought a store from Max for $ 20,000 (Invoice No. 953). 5. 5,1,xx We rented the store out for $ 700 cash (Invoice No.001)
We will practice making the bookkeeping records that are the subject of the above table (Comment: In the first part of the solution, the records will be presented in the form of a T account, and they will be presented textually in the second part. This will be explained more fully later on.
T ACCOUNTS Goods Debit Account Credit Waterman Account Debit Credit 1,000 (1) Electricity Expe Debit (2) 600 200 (3) (3) 200 Account Credit Max Debit Account Credit 20,000 (4) tal Account Credit 700 (5) (5) 700 Store Debit (4) 20,000 Store Ren Debit nses Account Credit
(1) 1,000 600 (2)
Cash Debit
Account Credit
Textual Records (Journal Entries) Debit (1) Debit Goods Account Account 1,000 on credit 1,000 Credit
Credit: 1.1.xx
Waterman Purchase
Invoice 123 (2) Debit: Cash Goods Account 600 Account 600
Credit:
2.1.xx Cash Sale, Receipt 1950 (3) Debit: Electricity Expenses Credit: Cash 200 200
3.1.xx Cash payment, Expenses Voucher 001 (4) Debit: Store Max Purchase of Account Account 20,000 Store,
Credit: 4.1.xx
20,000
Account 953 (5) Credit: Debit: Income from Cash 700 Rental
700
5.1.xx Cash Rental Account 001 22,500 22,500
Let's go over the entries together: Event 1: The Goods Account (a real account) is debited - because an account was received (Rule 1 in the table). The Waterman Account, (a personal account) is credited - as it is due to receive money (Rule 2 in the table). Event 2: The Cash Account (a real account) is debited - because the cash was received (Rule 2 in the table) The Goods Account (a real account) is credited - because the warehouse issued goods (Rule 2 in the table).
Event 3: The Electricity Expenses - (A profit and loss account) is debited - as every expense account is debited (Rule 3 in the table). Event 4: The Store Account (a real account) is debited - the transaction received a monetary value (Rule 2 in the table). The Max Account (a personal account) is credited - according to Rules 1 or 2. Event 5: The Income from the Rental Account (a profit and loss account) is a credit - as all receipts are a credit (Rule 3 in the table). The Cash Account is debited - according to Rule 2 in the table. Comment: It is easy to remember that every expense account is debited (the expense is a negative matter from an economic point of view and it is a debt of the business).Similarly, all receipts are a credit (a credit is something positive from an economic point of view and it is to the credit of the business). An additional stage that should be emphasized is that the first part (the T - Accounts) in fact serve us as a draft for the purpose of illustrating the records. In actual fact, the bookkeeping records are only inwords, the professional term for each record being a "Journal Entry: (or a "journal voucher"). A journal entry
Up until now we have seen that each single business transaction is recorded in a journal entry which is comprised of 2 components, a debit and a credit. A complete journal entry is comprised of the following components: 1. The account that is debited. 2. The account that is credited.
3. A row of particulars - including date, the type of transaction and the number of the document that is used as a reference for the transaction (receipt, invoice, check and so forth). Care should be taken to see that the credit line is always recorded a little to the right of the debit line. The function of the Journal entry is very simple, the immediate recording, as close as possible to the date on which the transaction is carried out, of all economic activities that occur in a business in chronological order (with the recording being made in the new language we have learned, bookkeeping language, that records each single transaction twice, once as a debit and once as a credit). We will take another step forward. Let us assume that in the above example there were not 5 records but 500. The question is whether we are able to obtain an immediate answer from the journal to the question, "What is the cash balance?" - It is clear that the answer is negative. For this purpose, we must go over 500 journal entries (1000 rows), and from these rows, sort out all the events in which a reference is made to the words 'Cash Account'. For this purpose, another system exists in bookkeeping that is known as the "Nominal ledger". The Journal and Nominal Ledger (General ledger)
In order to illustrate the connection between the journal and the nominal ledger, we will use a simple example - a daily paper. It is reasonable to assume that before the paper was printed, news was received in the editing room in a different form. A first, the news is received in the editing room in chronological order and not according to any classification of the news items. However, when the final product (the printed newspaper) is received, the news items have been classified and concentrated according to the common denominator of each section in the paper. Let us assume that items are received in the news room (by telex from various reporters - in the following form:
EDITING ROOM
It may be clearly that there are 2 separate systems in the newspaper: 1. The Editing Room -is characterized by a chronological order (and not according to specific subjects). 2. The sections of the newspaper edited according to the various subjects (sport, weather, economics, politics and so on). In the life of a business as described in bookkeeping, there are the same two systems. 1. The Journal-A textual record of events (Debit and Credit) that is characterized by the fact that all the records it contains are in a sequential chronological order. 2. The Nominal ledger (Also known as General Ledger, GP), Is made up of separate accounts for each matter (cash, banks, customers and so forth).
The accounts in the Nominal ledger look, technically, like the letter 'T' as was demonstrated previously at the start of this Tutorial. Let's try to describe the flow of the records in bookkeeping
Just as you, when you read a newspaper, go directly to the page in the paper that interests you (the sports section, the economics and so forth), when you use bookkeeping data you go directly to the relevant account in the Nominal ledger (the Max Account - will show you how much Max owes/is entitled to receive from/to pay to the business. The Cash Account - will show you how much money has been received/paid out.
The Structure of the Nominal ledger (General Ledger)
At the beginning of the tutorial, it was pointed out that an account in the Nominal ledger looks like the letter T. In fact, there are additional auxiliary data in the account Let us assume that January 1, xx, we received a loan in cash from Max in an amount of $10,000. The Journal Entry will look as follows: (let us assume that it concerns a voucher for which the serial number in the journal is xx):
xx Debit: Cash 10,000 Credit: Max 10,000 1.1.xx - Loan from Max, Receipt 013. The Journal Entry will be transferred to 2 accounts in the Nominal Ledger as follows: CASH ACCOUNT Debit Order Contra No. Date Value Ref. Details $ Loan xx Max 28.2.xx 1.1.xx R.013 from max 10,000 Credit
Account Recorded Date
MAX ACCOUNT Debit Credit Order Contra No. Date Value Ref. Details $
Account Recorded Date
xx
Cash
28.2.xx
1.1.xx R.013
Cash Loan
10,000
Let us analyze, for example, the "Cash" account. As you see in addition to the sum of $ 10,000 debited, there are other auxiliary data as follows: 1. Order Number-In our example, order xx. This is an important detail as the original document (Receipt 013) is filed under Journal Order Number xx 2. Contra Account This is the account that assisted, in the Journal entry to balance the record. If we go back to the journal entry, you will see that the contra account for the Cash is "*** Account". Therefore, in this column, we record "*** Account". 3. Date recorded The date on which the nominal ledger was updated. In the present instance, despite the fact that the event occurred on 1.1.xx, it was recorded in the nominal ledger only on 28.2.xx. 4. Value Date The date of the original document (in our case, the receipt was issued on 1.1.xx). 5. Reference This is the number of the original document (Receipt, invoice, etc.) 6. Details A short verbal description, similar in character to the details that appear in the Journal entry. Account - Flow and Balance Let us go back a little, to the example that was explained at the beginning of the tutorial, The Cash Account (in the Nominal Ledger) looks like this: Cash Debit 600 700 Accounts Credit 200
We will now learn two new concepts - Flow and Balance 1. Debit Flow This is all the records on the debit side of the account (in the example before us $ 1,300) (600 + 700). 2. Credit Flow This is all the records on the credit side of the account (in the example before us $ 200). 3. Debit Balance The difference between the debit transactions and the credit transactions (when the debit transactions exceed the credit transactions). 4. Credit Balance The difference between the credit transactions and the debit transactions (when the credit transactions exceed the debit transactions). In our example, there is a "Debit Balance" in the Cash Account (the total debit transactions exceed the credit transactions) of $ 1,100 (1300 200).
Before we go on to a comprehensive example, we will change the reference to the "Goods Account" a little. Until now, to keep matters simple, we have referred to the Goods Account as to a real account (the Warehouse Account), when on purchasing goods, we have debited the Goods Account (the warehouse 'received") and on selling goods, we have credited the Goods Account (the warehouse 'gave'). In fact, the reference to goods is different as the purchase prices ( 'in' to the warehouse) is normally lower that the price on leaving the warehouse (sale price).
The correct reference to the Goods Account is as to a normal profit and loss account, as for this purpose, 2 temporary bookkeeping accounts are opened: the first "Goods Purchased" (an expense - and therefore the account will normally be debited), the second "Goods Sold" (income - and therefore the account will normally be credited). A simple example appears below (the example ignores Value added tax):
1.1.xx We bought goods for cash for a sum of $ 1,000. 5.1.xx All the goods were sold for $ 1,200 cash.
The journal entries will be as follows: Debit Credit
1. Debit: Purchase of goods 1,000 Credit: Cash 1,000 Purchase of Goods, Invoice ..... 2. Credit: Debit: Sale of Cash 1,200 Goods 1,200
Cash sale. Receipt.....
Comprehensive Example
We will go on now to a comprehensive example that we will use until the end of this tutorial (in the example, we will try to imagine that your name is Miles and that you are the owner of a new business). Business data 1.1.xx We opened a new business in which we invested $ 10,000 dollars in cash. 2.1.xx We transferred $ 4,000 in cash to open a current bank account at the City Central Bank. 3.1.xx We bought office furnishings in the sum of $ 1,000 in cash. 4.1.xx We paid $ 600 in cash for office rental. 5.1.xx We bough a telephone with a check for $ 300.
30.1.xx We paid electricity expenses (by check) in an amount of $ 400. 1.2.xx We bought goods with a check for $ 1,200 (ignore the Value Added Tax). 2.2.xx We sold part of the goods for $ 1,000; the money received was deposited directly into the bank account. 3.2.xx We bought more goods with a check for $ 3,000. 4.2.xx We sold all the remaining goods for $ 5,000. The money received was deposited directly into the bank account. 28.2.xx The bank credited our account with interest in the amount of $ 100.
Pay attention to the journal entries while referring to the general debit/credit table at the beginning of the tutorial.
JOURNAL ENTRIES Debit Journal No. and Date Debit Credit Account Type Credit Rule No. Cash Owners 1. 1.1.xx Equity Owners Investment 10,000 10,000 Real Personal* 2 1
in Cash Current account 2. at 4,000 4,000 Real/Personal** 1-2 Real 2
2.1.xx City Central Cash Cash Deposit Fixed assets
3.
3.1.xx
Cash Purchase of furniture for Expenses for office
1,000 1,000
Real Real
2 2
rental 600 600 of
Temporary Real
3 2
4.
4.1.xx Cash Payment rent in cash Fixed assets City Central 300
5.
5.1.xx
current account Purchase of telephone Electricity expenses
Real 300 Real/Personal
2 1-2
6.
Central 400 30.1.xx current account Payment electricity Purchase of 1,200 of
City
400
Temporary Real/Personal
3 1-2
Temporary 1,200 Real/Personal
3 1-2
7.
1.2.xx goods City Central
current account Purchase of goods City Central
current account 8. 3.2.xx Sales goods Sale goods Purchase goods Central 3,000 3.2.xx current account Purchase of goods City Central 5,000 5,000 Real/Personal Temporary 1-2 3 City Temporary 3,000 Real/Personal 3 1-2 of of of 1,000 1,000 Real/Personal Temporary 3 1-2
9.
current 10. 4.2.xx account Sale of goods Sale goods City Central of
current account 11. 28.2.xx Income from 100 interest Income from interest, City and Central 100 Real/Personal Temporary 1-2 3
Current Account 26,600 26,600
Owners Equity Account
A normal personal account that is in credit as the owner of the business (Miles) "is credited as eligible" to receive from the business (refer to the business as a separate body) his basic investment in the sum of $ 10,000. To differentiate between the external creditors of the business (suppliers, lenders and so forth), and the owner of the business, the prefix "Owners Equity" appears at the beginning of the name of the account. Remember that from the point of view of the business, the business owners eligibility to be credited with $ 10,000 is not as important as the financial eligibility of a normal supplier to receive $ 10,000. In the current cash management of the business, the eligibility of the owner of the business can be almost completely ignored as this obligation is not immediately repayable.
** Current Account The account can be referred to as both a real account (like Cash) or as a personal account.
1. Real account Imagine for a moment that the money in the bank is in a metal cash box that belongs to you. On depositing money, the box "received" money (received - debit) while when drawing a check the box "gave" money (gave credit)
2. Personal Account In making a deposit in the current account it is as though the bank manager (personal) owes you money. When you draw money out of the account, the bank
manager owes you less than he did a moment before you made the withdrawal. (A reduction of a debit is expressed in bookkeeping as a credit transaction). Structure of the Nominal Ledger (General ledger)
Comment: For the sake of brevity, only the following details appear on each account page. 1. The journal entry number. 2. Name of the contra-account. 3. Description of the transaction. Cash Debit Accounts Credit 2. City Central current account 4,000 - Deposit 1. Owners Equity Investment 10,000 3. Fixed assets Furnishing 1,000
Rental _________ 4. expenses - 600 10,000 Rental ____________ 5,600
OWNERS EQU Debit
ITY ACCOUNT Credit 1. Cash Owners 10,000
Investments
CITY CENTRAL Debit 2. Cash - Deposit 8. Sale of goods Sales 10. Sale of goods Sales 11. Income from 4,000 1,000
CURRENT ACCOUNT Credit 5. Fixed Assets Telephone 6. expenses 5,000 Expenses 7. Purchase of 1,200 Electricity - 400 300
goods - Purchases 9. Purchase of
interest interest
Current 100
goods - Purchases _________ 10,100
3,000 _________ 4,900
FIXED ASSETS Debit 3. Cash - Furniture Purchase 5. City and Central current account - 300 1,000
ACCOUNT Credit
Telephone _________ 1,300
OFFICE RENTAL Debit 4. Cash - Rent 600
EXPENSES ACCOUNT Credit
ELECTRICITY EX Debit 6. City Central current of 400
PENSES ACCOUNT Credit
account expenses
Payment
PURCHASE OF Debit 7. City Central 1,200
GOODS ACCOUNT Credit
account-Goods purchase 9. City Central
account purchase
-Goods 3,000
_________ 4,200
SALE OF Debit
GOODS ACCOUNT Credit 8. City Central - 1,000
current Sales 10.
account
City
Central - 5,000
current Sales
account
_________ 6,000
INCOME FROM Debit
INTEREST ACCOUNT Credit 11. City Central Income current from 100
account interest
Trial Balance
After transferring the records to the Journal (Journal Entries) and from there to the account in the Nominal Ledger, the balance for each account is found (by hand or by using a computerized system). We will organize all the transactions and balance in every account in the nominal ledger into a table. This arrangement is called the Trial Balance.
Account Name Cash Owners Equity City Central current account Fixed assets Rental expenses Electricity expenses
Debit
Credit
Debit
Credit
Transaction Transaction Balance Balance 10,000 5,600 10,000 4,400 10,000
10,100
4,900
5,200
-
1,300
-
1,300
-
600
-
600
-
400
-
400
-
Purchase of goods Sales Goods Income from interest TOTAL of
4,200
-
4,200
-
-
6,000
-
6,000
-
100
-
100
26,600 =======
26,600 ======= 16,100 16,100
TOTAL
======= =======
The expression 'Trial Balance' comes, as is shown in the table, from the fact the debit and credit columns must balance (hence the word balance). Moreover the above table constitutes a trial (check) that the records in the journal have been properly transferred to the nominal ledger. It is important to point out that the fact that the Trial Balance (flow or balances) balances is not necessarily proof that the entries in the journal were recorded correctly. However, this subject is not under discussion just now. We will be content with pointing out the following main facts:
Trial Balance (Flow)
In addition to the fact that the "Debit Transaction" column is identical to the "credit transaction" column, both columns must be equal to the sum in the journal (in the example before you, the journal total was $ 26,600 as well.
The Trial Balance (Balances) This is in fact the more important of the two Trial Balances. In the Trial Balance (balances), the "Total Debit Balances" column must be identical to the "Total Credit Balances" column. Nevertheless, the column total (in our example, $ 16,100) will always be less than the journal total or the "Trial Balance (Flow)" column. As has been mentioned, the more important Trial Balance is the Trial Balance "(Balances)" as the balances are transferred directly from it to the two main statements that are prepared at the end of the year. The two statements are: A. The Profit and Loss Statement. B. The Balance Sheet. The two statements are known as the Annual Statements. Annual Statements
At the end of each year, the bookkeeping system produces two statements (directly from the Trial Balance). Let us assume that we are concerned with the year ending on December 12, xx. The two statements will be:
Statement 1 - The Profit and Loss Statement for the year ending December 31, xx. Statement 2 - The Balance Sheet as on December 31, xx. The Profit and Loss Statement In principle, it is important in the normal T account, when the debit side organizes all the accounts that end with the words "….Expense Account" while the credit side organizes all the accounts that end with the words "…. Receipts Account" and it is indeed logical that the Financial Statement is the total of all the receipts less the total expenses (Take care, as the Profit and Loss Accounts refers to a period of a year and not to the last day of the year. In other words. The Profit and Loss Statements is for the year ending on December 31, xx and does not show what the profit/loss was on the last day only, but for the entire year ending on December 31, xx)
Balance Sheet In principle go back to the normal T account where the debit side shows what assets belonged to the business while the credit side shows the obligations that the business has to other agencies.
Take care, as distinct from the Profit and Loss Statement that refers to the "Year ending December 31,xx" the Balance Sheet shows a photograph of the situation on the last day only.
Transfer from the Trial Balance We will go back to the Trial Balance (Balances) on the previous pages. Every balance will be transferred to the Profit and Loss Statement (if an expenses/receipts account is concerned) or to the Balance Sheet, while an iron rule that must be strictly observed is - "a balance cannot change its character" (in other words, a debit balance in the Trial Balance must be transferred to the debit side, whether on the Profit and Loss Statement or on the Balance Sheet, similarly a credit balance in the Trial Balance must appear only on the credit side, whether on the Profit and Loss Statement or on the Balance Sheet.
Profit & Loss State Debit
ment for the Year... Balance She Credit Goods 6,000 Debit Cash 4,400 Bank 100 curre 5,200 nt a/c __________ Fixed Asset 1,300 __ 6,100 s
et as at 31.12.xx Credit Owne rs equity __________ __ 10,000 10,000
Rent Expenses Elec.Expens es Goods Purchsd
600
sale Intere
400
st recd
4,200 _______ __ 5,200
Credit Balan ce (Profit) 900
_______ Profit for 900 __ 10,900 -------- ----------year 10,900
--
>
The Balance Sheet Structure
The Balance Sheet logic is completely consistent with the two basic rules (the rules of debit/credit) that were demonstrated at the beginning of the tutorial. 1. Debit Side- Describes either assets that belong to the business (property, a real account, according to Rule No. 2 an asset is always a debit) or debts owed by customers to us. Customers according to Rule No. 1 - are a personal account that must be a debit (the accounting entity must have a "debt" to the business). 2. Credit Side- Describes the obligations of the business to either of two factors as follows: 1. External agencies (suppliers, lenders and so forth). 2. The owner of the business (Capital Account or accumulated profits). In either case, according to Rule 1 either the external agencies or the owner of the business are eligible to be "credited" with money from the business and therefore they are in credit. Why does the Balance Sheet balance? In principle, there are two explanations for why the Balance Sheet must balance.
1. A Logical Explanation. The Balance Sheet is in fact made up of two parts while: The total assets of the business (the debit side) = The total obligations to external agencies (the credit side) + the total obligations to the owner of the business.
2. An accounting explanation The Balance Sheet is made up directly from the Trial Balance (Balances) which is itself a Balance Sheet. It is clear, therefore, that if we went from a Trial Balance to a Balance Sheet, then the final result (a Balance Sheet), that also takes account of the balance in the Profit and Loss Statement, will be balanced. Summary
In a graphic format, the accounting system looks like this
Survey of The Accounting System (Locating Irregularities)
At this stage, now that the subject of the Profit and Loss Statement and the is quite clear, during the year, you can easily survey the Nominal Ledger and locate balances which would appear to be unreasonable.
The logical test will be carried out according to the model in the following chart: Below is an example of unreasonable balances that need to be clarified with the bookkeepers: Personal Account Debit Credit Loan received Loan granted Goods purchases Goods sold ....Expenses ....Receipts Vehicles Real Estate Customers Suppliers + + + + + + + + + +
Bank Reconciliation
One of the most efficient and most commonly used tools for checking the accuracy of the bookkeeping system is a check known as the "Bank Reconciliation". This check is usually carried out once a month, at the end of the month.
What is Bank Reconciliation? Let us assume for the purpose of this example that your name is Miles and that you are at the end of June xx. Your accounts show that the current account at Western Union Bank has a debit balance of $ 1,000 (as was explained, it is possible to relate to a current account as a personal account. In other words on June 30, xx, the bank owes you $ 1,000). Logically, on June 30, xx, the Western Union Bank accounts should show that you, Miles, have a credit with the bank of $ 1,000. If the balance in the Bank's accounts (as may be seen easily from the bank statement that is received each month by every business) is identical, this proves that your bookkeeping is incredibly efficient, all communications with the bank, which is usually a main component in the activities of the business, were recorded correctly.
In reality, the situation is a little different. Almost always, balance at the end of the month can not be reconciled because, in the main, as a result of data that appear in only one of the systems (our bookkeeping, the bank's accounts) but not in both of them at once. The aim of the Bank Reconciliation is to attempt to locate the reasons for the discrepancies because of which the two balances are not reconciled. It is clear that after "neutralizing" the reasons for the irregularities that are the cause of the lack of reconciliation, the balances in both places must be identical.
An example: For purposes of the example, let us assume that the Western Union Bank accounts are to be reconciled to June 30,xx.
Details: The balance in Miles' account for the Western Union current account shows a debit balance of $ 1,000. The bank's accounts, on the other hand, show that on June 30, xx, Miles had a credit balance of $ 1,500. The reasons for the lack of reconciliation are as follows:
The amounts that appears on only thebank statement: 1. A credit for interest (current account) in an amount of $ 50 for June 30, xx (not recorded in Miles' accounts). 2. A debit for bank charges for the current account in an amount of $10 as of June 30, xx (not recorded in Miles' accounts).
3. A credit for a bank error in an amount of $ 300 dated June 27, xx, that belongs to Miller. Miles' account was credited in error (similar name). The amounts that appear only in Miles' accounts 1. A check for $ 160 that was paid to a supplier, that had not yet been paid in by the reconciliation date. Preparing the Bank Reconciliation Statement
The basic technique for finding the reason that the accounts are not reconciled is to prepare a "Reconciliation Statement", As a rule, check the following two possibilities for each item: 1. Does the transaction actually belong to us (Miles) - if so, if the transaction has only been recorded with the bank and not in our accounts - we must record it (the bank has already recorded it).
On the other hand, it the transaction has only be as recorded in our accounts and not in the bank's accounts, a parallel record should be made on the bank section in the reconciliation statement. 2. If the transaction does not belong to us - in this case the bank's records are in error, and the bank should correct its records. The Bank Reconciliation statement is in fact divided into 2 T accounts. The right side reflects our accounts (Miles' accounts) while the left side reflects the Bank's bookkeeping records that refer to us (in our case, it is reasonable to assume that in the records of the Western Union Bank, your account is called "Miles Account"). It is important to remember that from our point of view the current account with the Western Union may be referred to as a real account (the bank "owes" us or "is owed" by us, as may be the case. We will go on to a presentation of the Bank Reconciliation Statement:
RECONCILIATION OF THE WESTERN UNION BANK ACCOUNT AS AT JUNE 30, xx Miles Accounts Current Account with Western Details Union Bank Debit Balance to reconciliation date, 30.6.xx Amounts appearing only on the Bank Statement 30.6.xx Credit: Interest 30.6.xx Debit: Bank charges 27.6.xx Credit: Error (belongs to Miller) Amounts that appear only in our accounts 30.6.xx Check to supplier, Not yet presented to bank 1050 Adjusted Balance as at 30.6.xx 1,040 10 160 460 1,500 1,040 Debit 50 10 300 1,000 Credit Debit Credit the
Banks' Accounts "Miles" Account
1,500
Notice that at in preparing the Reconciliation Statement:
Heading: The name of the bank for which we are preparing the reconciliation statement and the date of the reconciliation (June 20, xx).
First Row: A record (it is preferable to circle it or mark it in bold) of the balance that appears in our accounts and at the bank as at June 30, xx pre-reconciliation. Amounts that appear only on the bank statement
1. Credit: Interest - The bank credited the account with $ 50 interest. From our point of view nothing has been recorded and therefore we will debit the bank with $ 50 (the Bank owes us another $ 50 in respect of the interest due to us). 2. Debit: Bank Charges - The bank has debited us with $ 10. From our point of view, the matter has not yet been recorded. It is clear that the bank is entitled to $10 (bank charges due to the bank). 3. Mistaken Credit - Deposit for Miller - The amount does not belong to us at all. The error is that of the bank. Therefore we will indicate in the bank section (the right side of the reconciliation statement) the fact that bank should debit us (this is how the bank will cancel the erroneous credit that appears in Miles' accounts). In the right hand part (Miles accounts) there is no need to record anything as from the start, we (Miles) have not made any record at all concerning the $ 300.
Amounts that appear only in our accounts.
Check not yet presented- As at the date of reconciliation, the bank does not yet know that $ 160 is about to be deducted from our account. Had the bank known this, it would have debited us with this amount (debit, reducing our credit balance). The last row - the adjusted balance of $ 1,040.
That is the real balance in our account today (and not $ 1,00 or $ 1,500 as appeared in the pre-reconciliation balances.
The adjusted - balance - $ 1,040 - must be the same in both sections of the reconciliation statement, If the amount does not agree, it proves that we have not found the cause of the lack of agreement.
Journal Entries as a result of the Reconciliation In our accounts (Miles' accounts) we have to make entries in the journal as a result of the amounts that appear on the right side of the Reconciliation Statement. The entries will be as follows: Debit Credit 1. Debit: Western Union current account Credit: Current 30.6.xx 2. Debit: Expenses for bank Income from Interest account interest 50 50
charges Credit: Western Union current 10 account Current Account Bank Charges - 30.6.xx 10
The Nominal Ledger, after the additional entries, will indeed, show a balance of $1,040 as follows: WESTERN UNION Debit Pre-reconciliation balance Interest 1,050 1,040 10 1,000 50 CURRENT ACCOUNT Credit
Bank Charges
10
Comment: In the above example, the causes for the lack of agreement were presented at the beginning of the exercise. In real life, they must be "extracted" by comparing our bookkeeping accounts with the bank statement we received. THE IMPORTANCE OF THE BANK RECONCILIATION
If the practice in your business is to reconcile the bank statement each month, your situation is relatively good. It is reasonable to assume that your bookkeeping is good. If, on the other hand, the last Bank Reconciliation is done in your business, let us assume, retrospectively for the last six months, you almost certainly have a problem. There is a reasonable chance that your Current Account in the bookkeeping system (as well as the rest of the system) is not up to date. Bookkeeping records
For your convenience, here are the journal entries that relate to 3 subjects that we will discuss at various points. The subjects are: Subject Salaries Income Tax Deduction at Source Value added tax
Salaries
As a general rule, two Journal Entries will suffice. The first - a reference to the net payment to employees (the figures are "extracted" directly from the payroll). The second - to take into consideration the existing employer's payments (the figures are "extracted" from relevant Income Tax and Social Security forms.
The Journal Entry is as follows: $ 1. Debit: Nathan Debit: Warren Debit: Bjorn Credit Bank current account 8.9.xx - Net Salary Payments 2. Debit: Salary expenses Debit: Employers' tax expense Debit: Social security expenses Credit: Nathan Credit: Warren Credit: Bjorn Credit: Income tax deductions Credit: Social Security deductions 15.9.xx - Salaries Entry 8/xx 3. Debit: Income tax deductions Debit: Social Security deductions Credit: Bank current account 15.9.xx - Payment of deductions, Salaries 3,278 ==== 4,180 152 412 855 1,290 1,133 850 _________ 616 4,744 ====== 850 616 ________ 1,466 1,466 ====== 1,466 ====== 4,744 ====== 833 1,290 1,330 3,278 3,278 ==== $
The Explanations for Journal Entry No. 2
a. Salary expenses - $ 4,180 The sum has been extracted from the payroll (the gross taxable total). b. Employers' tax expenses - $ 152 The sum has been taken directly from the relevant tax forms.
c. Social Security expenses This is the only amount in the Journal Entry that is not extracted from another source. This amount is arrived at using the following formula: $ Total due to Social Security (according to the relevant Social Security forms Less: Social Security deductions from employees (from the payroll data) The difference is the employer's contribution for Social Security 616
204
412 =======
Comment: The three debit accounts above are normal expenses accounts. Their final destination is, of course, in the Profit and Loss Statement.
d. Employees' Accounts (Nathan, Warren and Bjorn) These are normal personal accounts that are in credit at this stage, as the employees are eligible to be credited by the employer with their net salary.
e. Income Tax/Social Security Deductions There are normal personal accounts in respect of the Salaries for August xx. Both the institutions (Income Tax and Social Security) are entitled to be credited by the
employer
with
the
amounts
that
appear
in
their
relevant
forms.
Nominal Ledger Records The T accounts for the three above journal entries will look like this: Nathan Debit (1) 855 Current A/c Debit A/c Credit 855 (2) at A/c Credit 3,278 (2) 1,466 (3) Social S. Debit (2) 412 Expenses Income Deductions Social A/c Credit Tax Debit (3) 850 A/c Credit 850 (2) Deductions Bank Warren Debit (1) 1,290 Salaries Ex Debit (2) 4,180 A/c Credit Bjorn Debit A/c Credit 1,133 (2)
1,290 (2) (1) 1,133 penses A/c Credit
EmployersExpenses Tax Debit (2) 152 A/c Credit
Security A/c Debit (3) 616 Credit 616 (2)
Tax Deduction at Source
In general, 2 different bookkeeping accounts are needed: 1. The "Deductions at source from suppliers" Account - the account organizes the tax that was deducted from your suppliers or service providers as well as the tax paid to the tax authorities on the due date each month. 2. The tax deducted at source from customers. = the account organizes the tax deducted from you by your customers.
Records in the "Tax Deduction at Source from Suppliers" Account
Data : 1.4.xx - You paid $100 plus VAT of $15 for printing. You deducted tax at source at a rate of 20%. (115 x 20% = $ 23) 7.5.xx - You transferred a sum of $ 23 to the tax authorities.
Bookkeeping records Debit 1.4.xx 1. Office expenses Value added tax on inputs Bank current account tax deduction at source 115 100 15 92 23 115 Credit
7.5.xx 2
Tax deducted at source from suppliers Bank current account
23 23 23 === 23 ===
Visually, the accounts would look as follows: urce Deductions from at so suppliers Debit (1) 23 Credit 23 (1)
Office Debit
expenses VAT o Credit 100(1) Debit
n inputs Bank cur rent a/c Credit Debit Credit
15(1) (1)92
Take care as the "Deductions at source from suppliers" account is, in all ways, a personal credit and debit account. The card indicates the amount that the Income Tax is entitled to receive from you for tax you have deducted from suppliers. The balance of the account may be in credit (before you have transferred the deductions on the due date) or it may be at zero (after you have made the payment to the income tax) but it can never show a debit balance.
Records in the "Deductions at source from customers" account
Data: On 5.4.xx, you issued a tax invoice in the amount of $ 1,000 plus $ 150 value added tax. The payer deducted 20% ( $ 1,150 x 20% = $ 230). The cash balance was deposited directly into the Western Union Bank. The Bookkeeping records Debit 5.4.xx Western Union current account 920 Customer's deduction at source 230 Receipts VAT on transaction 1,150 1,000 150 1,150 Credit
Visually, the accounts will look as follows: Western Current Union Debit 920 A/c Credit Customer'sction at Inc dedu Debit source Debit Credit ome Credit 100 VAT on
transactions
Debit Credit 150
Take care as the "Deductions at source by customers" account is in all ways a personal debit and credit account. The account indicates the amount that the Income Tax owes you as a result of the fact that tax was deducted from you at source. The balance of the "deductions at source by customers" accounts may show zero if no tax was deducted from you, or it may show a debit but the account may never be in credit.
VALUE ADDED TAX (V.A.T.)
For the purposes of value added tax records, three bookkeeping accounts must be kept.
1. The VAT on inputs account. 2. The VAT on transactions account. 3. Debit and Credit VAT account. 1. The VAT on Inputs Account - This account will usually show a debit (the VAT authorities "owe" you money for the VAT you have paid and that are entitled to receive from them). 2. The VAT on Transactions Account - This account will usually show a credit (the VAT Authorities are "entitled" to receive the VAT from you that you have collected from them. The money is not yours and it is only temporarily in your possession until the due date for the payment of VAT.
3. The VAT Debit and Credit account. This is the account to which the 2 first accounts are posted. The account balance may show a credit, when the periodic report to the VAT is for a payment to be made, or it may show a debit when the periodic report shows that that money is to be returned. A simple example: 30.1.xx - The total purchases that you made amount to $ 1,000 plus $ 150 VAT on inputs. 30.1.xx - The total sales you made amount to $ 4,000 plus $ 600 VAT on transactions. 15.2.xx - You paid the balance to that VAT authorities that was owing to them.
The bookkeeping records will look as follows: Debit Credit 1. Purchases VAT on transactions Current account at bank (30.1.xx) Purchases recorded for January 1,000 150 1,150
2. Current account at bank Sales VAT on transactions (30.1.xx) Sales recorded for January
4,600 4,000 600
3. VAT on transactions VAT on inputs VAT debit and credit account (30.1.xx) Transfer of surplus to debit & credit account
600 150 450
4. VAT debit and credit account Current account at bank (15.2.xx)Payment of VAT reported for January
450 450
BOOKKEEPING CONVENTIONS Bookkeeping language is based on 2 basic conventions: 1. The Convention of the Common Monetary Denominator
Try to add the following two data: Let us assume that you are deal in textiles. On the 15th of the month, you bought 13 kilogram of fabric and 17 meters of material.
It is clear that adding the 2 numbers (13 and 17) amounts to 30 but it lacks all significance as the base is different (a kilogram - a unit of weight as compared to a meter - a unit of length). However, if we add the following data to the example, we will reach a logical result. Let us assume that the material is $ 1,000 a kilo or $ 50 a meter, you can state in monetary terms that you bought goods with a value of $13,850/(13 x $ 1000 = $ 13,000 plus 17 x $ 50 = $ 850, Total $ 13,850) It is clear, therefore, that the common basis for every bookkeeping record is the monetary value. 2. The "Dual Aspect" Convention. This convention is in fact at the very heart of a bookkeeping system. Let us take an example of an economic transaction done in the Middle Ages. Jo brings a kg. of fish to the market and in exchange he buys a pair of shoes from Jake. Each of the parties to the transaction "received" a certain economic value and "gave" an identical value. Jo - "received": a pair of shoes and "gave" a kilo of fish Jake - "received" a kilo of fish and "gave" a pair of shoes
3. At this stage, you are of course wondering why we have taken an example from the Middle Ages for commercial life in the 21st century. I am sorry to disappoint you but the situation is very similar today.
Let's alter the previous example to suit our times. Let's assume that Jo buys a
pair of shows from Jake for $ 80. We can see here as well that although we are concerned with a single commercial transaction (from Jo's point of view buying shoes for cash, from Jake's point of view - selling shoes for cash). We are still left with the "dual aspect" convention as follows: Jo - "received" goods (shoes) and "gave" money Jake - "received" money and "gave" goods (shoes)
4. In other words, the language of bookkeeping tends to record a single transaction in dual manner. Once, what the tradesman "received", and the second time, what that same trader "gave". In bookkeeping, each single" commercial The Double Entry Convention transaction is recorded twice. On the "Received" side and then again on the "Gave" side
1. DIVIDING THE TRANSACTION INTO SUBSIDIARY COMPONENTS Bookkeeping Does not refer to a business as a single unit but as a body that contains a number of subsidiary units with a particular person being responsible for each subsidiary unit.
In order to organize the business activities, we will take a separate sheet of paper that will organize all the activities that are connected to the person in charge.
So for example, the Cash Page - will describe everything connected with the cashier, the Goods Page - will describe everything that is connected with the warehouseman, while the Bank Page - will coordinate all that is connected with the person that deals with the banks.
Event 1 - We bought goods for $100 cash. Event 2 - We transferred $60 in cash to our bank account. Event 3 - We bought goods from a supplier for $30 that we took out of cash.
The bookkeeping records are as follows: Event 1: Goods Page Received Warehouseman Gave Cash Page Cashier Gave
Received
100 (1)
100 (1)
The explanation is very simple: The Goods Page - that describes the events from the point of view of the warehouseman - received an economic value of $ 100. The Cash Page - that describes the event from the point of view of the cashier - gave $ 100. Comment - The decision that the left side of the page reflects "Received" while the right side shows "Gave" has no logical explanation and it is a convention adopted for the sake of uniformity only (rather like the rule that all vehicles travel in the right lane on the roads in most countries, a safety regulation that affects everyone in principle (uniformity).
Further Comment: The professional expression for each bookkeeping page is not the "Goods Page" and/or the "Cash Page" but ACCOUNT (as distinct from an account submitted to a supplier for goods or services he :gave" or a tax invoice), somewhat similar to the expression "Report".
From this stage on, we will use the expressions "Goods Account" and Cash Account" and so on. Event 2: Let's sketch "Accounts" (pages). It is obvious that the relevant accounts are: the "Bank Account that describes what happened in the transaction from the point of view of the person in charge of the account with the bank and the "Bank Account". The record will look as follows: Goods Page Received Warehouseman Gave Cash Page Cashier Gave
Received
60 (2)
60 (2)
Event 3: The record will look like this: Goods Page Received Warehouseman Gave Cash Page Cashier Gave
Received
30 (3)
30 (3)
In actual practice, the account looks somewhat different. The three sides are removed from the original account and the resulting format resembles the letter 'T'. In fact, the custom is to call accounts by the name 'T Accounts'.
Bookkeeping Course: TYPES OF ACCOUNTS 1. PERSONAL ACCOUNT - Any account that bears the name of a particular person (including, of course, names of companies, suppliers, customers and so forth). For instance, the Walters Account, the Mortimer Account, the Calvin Motors Ltd. Account, and more. 2. REAL ACCOUNT - Any account for which that recorded on the account can be really verified. For instance, the Cash Account (if the Cash Account shows that we received $ 80, then we can check physically to see if we have $ 80 in cash). Another example is the Goods Account. If the Account shows that we received goods worth $ 100, then goods to that value should be physically present in the warehouse. 3. PROFIT AND LOSS ACCOUNT- Any account that describes an expense or receipts (the name of the account will always be followed by the words ' ... Expense Account' or '... Receipts Account'}.
Until now we have learned that the left hand side of the account is called 'Received' and the right hand side is called 'Gave'. The correct expressions that are used in the profession are: The left hand side (the 'Received' side)- the Debit Side. The right hand side (the 'Gave' side)- the Credit Side. Moreover, there are clear rules as to when to debit the account (that is to say, to enter the record on the left hand side) and when to credit the account (that is to say,
to enter the record in the right hand side). We shall use the following tables and the example that follows it to help us understand more fully: THE DEBIT AND CREDIT RULES Type Account of
To Debit the Account When the person whose
To Credit the Account
1. Personal
in
whose
name
the
When
the
person
in
account is kept is in debt to us When the account money/the
whose name the account is kept is in credit with us
2. Real
received equivalent
When the account gives us money/the equivalent
3.
Profit and Loss
Any account that ends Any account that ends with the words 'Expense with the words 'Revenue Accounts'. Account'
Comprehensive Example: 1. 1.1.xx We bought goods from Waterman for an overall sum of $ 1,000 (Invoice No. 123).
2. 2.1.xx We sold part of the goods for $ 600 cash (Receipt No. 1950) 3. 3.1.xx We paid $ 200 cash for electricity expenses (Expense Voucher 001). 4. 4.1.xx We bought a store from Max for $ 20,000 (Invoice No. 953). 5. 5,1,xx We rented the store out for $ 700 cash (Invoice No.001)
We will practice making the bookkeeping records that are the subject of the above table (Comment: In the first part of the solution, the records will be presented in the form of a T account, and they will be presented textually in the second part. This will be explained more fully later on.
T ACCOUNTS Goods Debit Account Credit Waterman Account Debit Credit 1,000 (1) Electricity Expe Debit (2) 600 200 (3) (3) 200 Account Credit Max Debit Account Credit 20,000 (4) tal Account Credit 700 (5) (5) 700 Store Debit (4) 20,000 Store Ren Debit nses Account Credit
(1) 1,000 600 (2)
Cash Debit
Account Credit
Textual Records (Journal Entries) Debit (1) Debit Goods Account Account 1,000 on credit 1,000 Credit
Credit: 1.1.xx
Waterman Purchase
Invoice 123 (2) Debit: Cash Goods Account 600 Account 600
Credit:
2.1.xx Cash Sale, Receipt 1950 (3) Debit: Electricity Expenses Credit: Cash 200 200
3.1.xx Cash payment, Expenses Voucher 001 (4) Debit: Store Max Purchase of Account Account 20,000 Store,
Credit: 4.1.xx
20,000
Account 953 (5) Credit: Debit: Income from Cash 700 Rental
700
5.1.xx Cash Rental Account 001 22,500 22,500
Let's go over the entries together: Event 1: The Goods Account (a real account) is debited - because an account was received (Rule 1 in the table). The Waterman Account, (a personal account) is credited - as it is due to receive money (Rule 2 in the table). Event 2: The Cash Account (a real account) is debited - because the cash was received (Rule 2 in the table) The Goods Account (a real account) is credited - because the warehouse issued goods (Rule 2 in the table).
Event 3: The Electricity Expenses - (A profit and loss account) is debited - as every expense account is debited (Rule 3 in the table). Event 4: The Store Account (a real account) is debited - the transaction received a monetary value (Rule 2 in the table). The Max Account (a personal account) is credited - according to Rules 1 or 2. Event 5: The Income from the Rental Account (a profit and loss account) is a credit - as all receipts are a credit (Rule 3 in the table). The Cash Account is debited - according to Rule 2 in the table. Comment: It is easy to remember that every expense account is debited (the expense is a negative matter from an economic point of view and it is a debt of the business).Similarly, all receipts are a credit (a credit is something positive from an economic point of view and it is to the credit of the business). An additional stage that should be emphasized is that the first part (the T - Accounts) in fact serve us as a draft for the purpose of illustrating the records. In actual fact, the bookkeeping records are only inwords, the professional term for each record being a "Journal Entry: (or a "journal voucher"). A journal entry
Up until now we have seen that each single business transaction is recorded in a journal entry which is comprised of 2 components, a debit and a credit. A complete journal entry is comprised of the following components: 1. The account that is debited. 2. The account that is credited.
3. A row of particulars - including date, the type of transaction and the number of the document that is used as a reference for the transaction (receipt, invoice, check and so forth). Care should be taken to see that the credit line is always recorded a little to the right of the debit line. The function of the Journal entry is very simple, the immediate recording, as close as possible to the date on which the transaction is carried out, of all economic activities that occur in a business in chronological order (with the recording being made in the new language we have learned, bookkeeping language, that records each single transaction twice, once as a debit and once as a credit). We will take another step forward. Let us assume that in the above example there were not 5 records but 500. The question is whether we are able to obtain an immediate answer from the journal to the question, "What is the cash balance?" - It is clear that the answer is negative. For this purpose, we must go over 500 journal entries (1000 rows), and from these rows, sort out all the events in which a reference is made to the words 'Cash Account'. For this purpose, another system exists in bookkeeping that is known as the "Nominal ledger". The Journal and Nominal Ledger (General ledger)
In order to illustrate the connection between the journal and the nominal ledger, we will use a simple example - a daily paper. It is reasonable to assume that before the paper was printed, news was received in the editing room in a different form. A first, the news is received in the editing room in chronological order and not according to any classification of the news items. However, when the final product (the printed newspaper) is received, the news items have been classified and concentrated according to the common denominator of each section in the paper. Let us assume that items are received in the news room (by telex from various reporters - in the following form:
EDITING ROOM
It may be clearly that there are 2 separate systems in the newspaper: 1. The Editing Room -is characterized by a chronological order (and not according to specific subjects). 2. The sections of the newspaper edited according to the various subjects (sport, weather, economics, politics and so on). In the life of a business as described in bookkeeping, there are the same two systems. 1. The Journal-A textual record of events (Debit and Credit) that is characterized by the fact that all the records it contains are in a sequential chronological order. 2. The Nominal ledger (Also known as General Ledger, GP), Is made up of separate accounts for each matter (cash, banks, customers and so forth).
The accounts in the Nominal ledger look, technically, like the letter 'T' as was demonstrated previously at the start of this Tutorial. Let's try to describe the flow of the records in bookkeeping
Just as you, when you read a newspaper, go directly to the page in the paper that interests you (the sports section, the economics and so forth), when you use bookkeeping data you go directly to the relevant account in the Nominal ledger (the Max Account - will show you how much Max owes/is entitled to receive from/to pay to the business. The Cash Account - will show you how much money has been received/paid out.
The Structure of the Nominal ledger (General Ledger)
At the beginning of the tutorial, it was pointed out that an account in the Nominal ledger looks like the letter T. In fact, there are additional auxiliary data in the account Let us assume that January 1, xx, we received a loan in cash from Max in an amount of $10,000. The Journal Entry will look as follows: (let us assume that it concerns a voucher for which the serial number in the journal is xx):
xx Debit: Cash 10,000 Credit: Max 10,000 1.1.xx - Loan from Max, Receipt 013. The Journal Entry will be transferred to 2 accounts in the Nominal Ledger as follows: CASH ACCOUNT Debit Order Contra No. Date Value Ref. Details $ Loan xx Max 28.2.xx 1.1.xx R.013 from max 10,000 Credit
Account Recorded Date
MAX ACCOUNT Debit Credit Order Contra No. Date Value Ref. Details $
Account Recorded Date
xx
Cash
28.2.xx
1.1.xx R.013
Cash Loan
10,000
Let us analyze, for example, the "Cash" account. As you see in addition to the sum of $ 10,000 debited, there are other auxiliary data as follows: 1. Order Number-In our example, order xx. This is an important detail as the original document (Receipt 013) is filed under Journal Order Number xx 2. Contra Account This is the account that assisted, in the Journal entry to balance the record. If we go back to the journal entry, you will see that the contra account for the Cash is "*** Account". Therefore, in this column, we record "*** Account". 3. Date recorded The date on which the nominal ledger was updated. In the present instance, despite the fact that the event occurred on 1.1.xx, it was recorded in the nominal ledger only on 28.2.xx. 4. Value Date The date of the original document (in our case, the receipt was issued on 1.1.xx). 5. Reference This is the number of the original document (Receipt, invoice, etc.) 6. Details A short verbal description, similar in character to the details that appear in the Journal entry. Account - Flow and Balance Let us go back a little, to the example that was explained at the beginning of the tutorial, The Cash Account (in the Nominal Ledger) looks like this: Cash Debit 600 700 Accounts Credit 200
We will now learn two new concepts - Flow and Balance 1. Debit Flow This is all the records on the debit side of the account (in the example before us $ 1,300) (600 + 700). 2. Credit Flow This is all the records on the credit side of the account (in the example before us $ 200). 3. Debit Balance The difference between the debit transactions and the credit transactions (when the debit transactions exceed the credit transactions). 4. Credit Balance The difference between the credit transactions and the debit transactions (when the credit transactions exceed the debit transactions). In our example, there is a "Debit Balance" in the Cash Account (the total debit transactions exceed the credit transactions) of $ 1,100 (1300 200).
Before we go on to a comprehensive example, we will change the reference to the "Goods Account" a little. Until now, to keep matters simple, we have referred to the Goods Account as to a real account (the Warehouse Account), when on purchasing goods, we have debited the Goods Account (the warehouse 'received") and on selling goods, we have credited the Goods Account (the warehouse 'gave'). In fact, the reference to goods is different as the purchase prices ( 'in' to the warehouse) is normally lower that the price on leaving the warehouse (sale price).
The correct reference to the Goods Account is as to a normal profit and loss account, as for this purpose, 2 temporary bookkeeping accounts are opened: the first "Goods Purchased" (an expense - and therefore the account will normally be debited), the second "Goods Sold" (income - and therefore the account will normally be credited). A simple example appears below (the example ignores Value added tax):
1.1.xx We bought goods for cash for a sum of $ 1,000. 5.1.xx All the goods were sold for $ 1,200 cash.
The journal entries will be as follows: Debit Credit
1. Debit: Purchase of goods 1,000 Credit: Cash 1,000 Purchase of Goods, Invoice ..... 2. Credit: Debit: Sale of Cash 1,200 Goods 1,200
Cash sale. Receipt.....
Comprehensive Example
We will go on now to a comprehensive example that we will use until the end of this tutorial (in the example, we will try to imagine that your name is Miles and that you are the owner of a new business). Business data 1.1.xx We opened a new business in which we invested $ 10,000 dollars in cash. 2.1.xx We transferred $ 4,000 in cash to open a current bank account at the City Central Bank. 3.1.xx We bought office furnishings in the sum of $ 1,000 in cash. 4.1.xx We paid $ 600 in cash for office rental. 5.1.xx We bough a telephone with a check for $ 300.
30.1.xx We paid electricity expenses (by check) in an amount of $ 400. 1.2.xx We bought goods with a check for $ 1,200 (ignore the Value Added Tax). 2.2.xx We sold part of the goods for $ 1,000; the money received was deposited directly into the bank account. 3.2.xx We bought more goods with a check for $ 3,000. 4.2.xx We sold all the remaining goods for $ 5,000. The money received was deposited directly into the bank account. 28.2.xx The bank credited our account with interest in the amount of $ 100.
Pay attention to the journal entries while referring to the general debit/credit table at the beginning of the tutorial.
JOURNAL ENTRIES Debit Journal No. and Date Debit Credit Account Type Credit Rule No. Cash Owners 1. 1.1.xx Equity Owners Investment 10,000 10,000 Real Personal* 2 1
in Cash Current account 2. at 4,000 4,000 Real/Personal** 1-2 Real 2
2.1.xx City Central Cash Cash Deposit Fixed assets
3.
3.1.xx
Cash Purchase of furniture for Expenses for office
1,000 1,000
Real Real
2 2
rental 600 600 of
Temporary Real
3 2
4.
4.1.xx Cash Payment rent in cash Fixed assets City Central 300
5.
5.1.xx
current account Purchase of telephone Electricity expenses
Real 300 Real/Personal
2 1-2
6.
Central 400 30.1.xx current account Payment electricity Purchase of 1,200 of
City
400
Temporary Real/Personal
3 1-2
Temporary 1,200 Real/Personal
3 1-2
7.
1.2.xx goods City Central
current account Purchase of goods City Central
current account 8. 3.2.xx Sales goods Sale goods Purchase goods Central 3,000 3.2.xx current account Purchase of goods City Central 5,000 5,000 Real/Personal Temporary 1-2 3 City Temporary 3,000 Real/Personal 3 1-2 of of of 1,000 1,000 Real/Personal Temporary 3 1-2
9.
current 10. 4.2.xx account Sale of goods Sale goods City Central of
current account 11. 28.2.xx Income from 100 interest Income from interest, City and Central 100 Real/Personal Temporary 1-2 3
Current Account 26,600 26,600
Owners Equity Account
A normal personal account that is in credit as the owner of the business (Miles) "is credited as eligible" to receive from the business (refer to the business as a separate body) his basic investment in the sum of $ 10,000. To differentiate between the external creditors of the business (suppliers, lenders and so forth), and the owner of the business, the prefix "Owners Equity" appears at the beginning of the name of the account. Remember that from the point of view of the business, the business owners eligibility to be credited with $ 10,000 is not as important as the financial eligibility of a normal supplier to receive $ 10,000. In the current cash management of the business, the eligibility of the owner of the business can be almost completely ignored as this obligation is not immediately repayable.
** Current Account The account can be referred to as both a real account (like Cash) or as a personal account.
1. Real account Imagine for a moment that the money in the bank is in a metal cash box that belongs to you. On depositing money, the box "received" money (received - debit) while when drawing a check the box "gave" money (gave credit)
2. Personal Account In making a deposit in the current account it is as though the bank manager (personal) owes you money. When you draw money out of the account, the bank
manager owes you less than he did a moment before you made the withdrawal. (A reduction of a debit is expressed in bookkeeping as a credit transaction). Structure of the Nominal Ledger (General ledger)
Comment: For the sake of brevity, only the following details appear on each account page. 1. The journal entry number. 2. Name of the contra-account. 3. Description of the transaction. Cash Debit Accounts Credit 2. City Central current account 4,000 - Deposit 1. Owners Equity Investment 10,000 3. Fixed assets Furnishing 1,000
Rental _________ 4. expenses - 600 10,000 Rental ____________ 5,600
OWNERS EQU Debit
ITY ACCOUNT Credit 1. Cash Owners 10,000
Investments
CITY CENTRAL Debit 2. Cash - Deposit 8. Sale of goods Sales 10. Sale of goods Sales 11. Income from 4,000 1,000
CURRENT ACCOUNT Credit 5. Fixed Assets Telephone 6. expenses 5,000 Expenses 7. Purchase of 1,200 Electricity - 400 300
goods - Purchases 9. Purchase of
interest interest
Current 100
goods - Purchases _________ 10,100
3,000 _________ 4,900
FIXED ASSETS Debit 3. Cash - Furniture Purchase 5. City and Central current account - 300 1,000
ACCOUNT Credit
Telephone _________ 1,300
OFFICE RENTAL Debit 4. Cash - Rent 600
EXPENSES ACCOUNT Credit
ELECTRICITY EX Debit 6. City Central current of 400
PENSES ACCOUNT Credit
account expenses
Payment
PURCHASE OF Debit 7. City Central 1,200
GOODS ACCOUNT Credit
account-Goods purchase 9. City Central
account purchase
-Goods 3,000
_________ 4,200
SALE OF Debit
GOODS ACCOUNT Credit 8. City Central - 1,000
current Sales 10.
account
City
Central - 5,000
current Sales
account
_________ 6,000
INCOME FROM Debit
INTEREST ACCOUNT Credit 11. City Central Income current from 100
account interest
Trial Balance
After transferring the records to the Journal (Journal Entries) and from there to the account in the Nominal Ledger, the balance for each account is found (by hand or by using a computerized system). We will organize all the transactions and balance in every account in the nominal ledger into a table. This arrangement is called the Trial Balance.
Account Name Cash Owners Equity City Central current account Fixed assets Rental expenses Electricity expenses
Debit
Credit
Debit
Credit
Transaction Transaction Balance Balance 10,000 5,600 10,000 4,400 10,000
10,100
4,900
5,200
-
1,300
-
1,300
-
600
-
600
-
400
-
400
-
Purchase of goods Sales Goods Income from interest TOTAL of
4,200
-
4,200
-
-
6,000
-
6,000
-
100
-
100
26,600 =======
26,600 ======= 16,100 16,100
TOTAL
======= =======
The expression 'Trial Balance' comes, as is shown in the table, from the fact the debit and credit columns must balance (hence the word balance). Moreover the above table constitutes a trial (check) that the records in the journal have been properly transferred to the nominal ledger. It is important to point out that the fact that the Trial Balance (flow or balances) balances is not necessarily proof that the entries in the journal were recorded correctly. However, this subject is not under discussion just now. We will be content with pointing out the following main facts:
Trial Balance (Flow)
In addition to the fact that the "Debit Transaction" column is identical to the "credit transaction" column, both columns must be equal to the sum in the journal (in the example before you, the journal total was $ 26,600 as well.
The Trial Balance (Balances) This is in fact the more important of the two Trial Balances. In the Trial Balance (balances), the "Total Debit Balances" column must be identical to the "Total Credit Balances" column. Nevertheless, the column total (in our example, $ 16,100) will always be less than the journal total or the "Trial Balance (Flow)" column. As has been mentioned, the more important Trial Balance is the Trial Balance "(Balances)" as the balances are transferred directly from it to the two main statements that are prepared at the end of the year. The two statements are: A. The Profit and Loss Statement. B. The Balance Sheet. The two statements are known as the Annual Statements. Annual Statements
At the end of each year, the bookkeeping system produces two statements (directly from the Trial Balance). Let us assume that we are concerned with the year ending on December 12, xx. The two statements will be:
Statement 1 - The Profit and Loss Statement for the year ending December 31, xx. Statement 2 - The Balance Sheet as on December 31, xx. The Profit and Loss Statement In principle, it is important in the normal T account, when the debit side organizes all the accounts that end with the words "….Expense Account" while the credit side organizes all the accounts that end with the words "…. Receipts Account" and it is indeed logical that the Financial Statement is the total of all the receipts less the total expenses (Take care, as the Profit and Loss Accounts refers to a period of a year and not to the last day of the year. In other words. The Profit and Loss Statements is for the year ending on December 31, xx and does not show what the profit/loss was on the last day only, but for the entire year ending on December 31, xx)
Balance Sheet In principle go back to the normal T account where the debit side shows what assets belonged to the business while the credit side shows the obligations that the business has to other agencies.
Take care, as distinct from the Profit and Loss Statement that refers to the "Year ending December 31,xx" the Balance Sheet shows a photograph of the situation on the last day only.
Transfer from the Trial Balance We will go back to the Trial Balance (Balances) on the previous pages. Every balance will be transferred to the Profit and Loss Statement (if an expenses/receipts account is concerned) or to the Balance Sheet, while an iron rule that must be strictly observed is - "a balance cannot change its character" (in other words, a debit balance in the Trial Balance must be transferred to the debit side, whether on the Profit and Loss Statement or on the Balance Sheet, similarly a credit balance in the Trial Balance must appear only on the credit side, whether on the Profit and Loss Statement or on the Balance Sheet.
Profit & Loss State Debit
ment for the Year... Balance She Credit Goods 6,000 Debit Cash 4,400 Bank 100 curre 5,200 nt a/c __________ Fixed Asset 1,300 __ 6,100 s
et as at 31.12.xx Credit Owne rs equity __________ __ 10,000 10,000
Rent Expenses Elec.Expens es Goods Purchsd
600
sale Intere
400
st recd
4,200 _______ __ 5,200
Credit Balan ce (Profit) 900
_______ Profit for 900 __ 10,900 -------- ----------year 10,900
--
>
The Balance Sheet Structure
The Balance Sheet logic is completely consistent with the two basic rules (the rules of debit/credit) that were demonstrated at the beginning of the tutorial. 1. Debit Side- Describes either assets that belong to the business (property, a real account, according to Rule No. 2 an asset is always a debit) or debts owed by customers to us. Customers according to Rule No. 1 - are a personal account that must be a debit (the accounting entity must have a "debt" to the business). 2. Credit Side- Describes the obligations of the business to either of two factors as follows: 1. External agencies (suppliers, lenders and so forth). 2. The owner of the business (Capital Account or accumulated profits). In either case, according to Rule 1 either the external agencies or the owner of the business are eligible to be "credited" with money from the business and therefore they are in credit. Why does the Balance Sheet balance? In principle, there are two explanations for why the Balance Sheet must balance.
1. A Logical Explanation. The Balance Sheet is in fact made up of two parts while: The total assets of the business (the debit side) = The total obligations to external agencies (the credit side) + the total obligations to the owner of the business.
2. An accounting explanation The Balance Sheet is made up directly from the Trial Balance (Balances) which is itself a Balance Sheet. It is clear, therefore, that if we went from a Trial Balance to a Balance Sheet, then the final result (a Balance Sheet), that also takes account of the balance in the Profit and Loss Statement, will be balanced. Summary
In a graphic format, the accounting system looks like this
Survey of The Accounting System (Locating Irregularities)
At this stage, now that the subject of the Profit and Loss Statement and the is quite clear, during the year, you can easily survey the Nominal Ledger and locate balances which would appear to be unreasonable.
The logical test will be carried out according to the model in the following chart: Below is an example of unreasonable balances that need to be clarified with the bookkeepers: Personal Account Debit Credit Loan received Loan granted Goods purchases Goods sold ....Expenses ....Receipts Vehicles Real Estate Customers Suppliers + + + + + + + + + +
Bank Reconciliation
One of the most efficient and most commonly used tools for checking the accuracy of the bookkeeping system is a check known as the "Bank Reconciliation". This check is usually carried out once a month, at the end of the month.
What is Bank Reconciliation? Let us assume for the purpose of this example that your name is Miles and that you are at the end of June xx. Your accounts show that the current account at Western Union Bank has a debit balance of $ 1,000 (as was explained, it is possible to relate to a current account as a personal account. In other words on June 30, xx, the bank owes you $ 1,000). Logically, on June 30, xx, the Western Union Bank accounts should show that you, Miles, have a credit with the bank of $ 1,000. If the balance in the Bank's accounts (as may be seen easily from the bank statement that is received each month by every business) is identical, this proves that your bookkeeping is incredibly efficient, all communications with the bank, which is usually a main component in the activities of the business, were recorded correctly.
In reality, the situation is a little different. Almost always, balance at the end of the month can not be reconciled because, in the main, as a result of data that appear in only one of the systems (our bookkeeping, the bank's accounts) but not in both of them at once. The aim of the Bank Reconciliation is to attempt to locate the reasons for the discrepancies because of which the two balances are not reconciled. It is clear that after "neutralizing" the reasons for the irregularities that are the cause of the lack of reconciliation, the balances in both places must be identical.
An example: For purposes of the example, let us assume that the Western Union Bank accounts are to be reconciled to June 30,xx.
Details: The balance in Miles' account for the Western Union current account shows a debit balance of $ 1,000. The bank's accounts, on the other hand, show that on June 30, xx, Miles had a credit balance of $ 1,500. The reasons for the lack of reconciliation are as follows:
The amounts that appears on only thebank statement: 1. A credit for interest (current account) in an amount of $ 50 for June 30, xx (not recorded in Miles' accounts). 2. A debit for bank charges for the current account in an amount of $10 as of June 30, xx (not recorded in Miles' accounts).
3. A credit for a bank error in an amount of $ 300 dated June 27, xx, that belongs to Miller. Miles' account was credited in error (similar name). The amounts that appear only in Miles' accounts 1. A check for $ 160 that was paid to a supplier, that had not yet been paid in by the reconciliation date. Preparing the Bank Reconciliation Statement
The basic technique for finding the reason that the accounts are not reconciled is to prepare a "Reconciliation Statement", As a rule, check the following two possibilities for each item: 1. Does the transaction actually belong to us (Miles) - if so, if the transaction has only been recorded with the bank and not in our accounts - we must record it (the bank has already recorded it).
On the other hand, it the transaction has only be as recorded in our accounts and not in the bank's accounts, a parallel record should be made on the bank section in the reconciliation statement. 2. If the transaction does not belong to us - in this case the bank's records are in error, and the bank should correct its records. The Bank Reconciliation statement is in fact divided into 2 T accounts. The right side reflects our accounts (Miles' accounts) while the left side reflects the Bank's bookkeeping records that refer to us (in our case, it is reasonable to assume that in the records of the Western Union Bank, your account is called "Miles Account"). It is important to remember that from our point of view the current account with the Western Union may be referred to as a real account (the bank "owes" us or "is owed" by us, as may be the case. We will go on to a presentation of the Bank Reconciliation Statement:
RECONCILIATION OF THE WESTERN UNION BANK ACCOUNT AS AT JUNE 30, xx Miles Accounts Current Account with Western Details Union Bank Debit Balance to reconciliation date, 30.6.xx Amounts appearing only on the Bank Statement 30.6.xx Credit: Interest 30.6.xx Debit: Bank charges 27.6.xx Credit: Error (belongs to Miller) Amounts that appear only in our accounts 30.6.xx Check to supplier, Not yet presented to bank 1050 Adjusted Balance as at 30.6.xx 1,040 10 160 460 1,500 1,040 Debit 50 10 300 1,000 Credit Debit Credit the
Banks' Accounts "Miles" Account
1,500
Notice that at in preparing the Reconciliation Statement:
Heading: The name of the bank for which we are preparing the reconciliation statement and the date of the reconciliation (June 20, xx).
First Row: A record (it is preferable to circle it or mark it in bold) of the balance that appears in our accounts and at the bank as at June 30, xx pre-reconciliation. Amounts that appear only on the bank statement
1. Credit: Interest - The bank credited the account with $ 50 interest. From our point of view nothing has been recorded and therefore we will debit the bank with $ 50 (the Bank owes us another $ 50 in respect of the interest due to us). 2. Debit: Bank Charges - The bank has debited us with $ 10. From our point of view, the matter has not yet been recorded. It is clear that the bank is entitled to $10 (bank charges due to the bank). 3. Mistaken Credit - Deposit for Miller - The amount does not belong to us at all. The error is that of the bank. Therefore we will indicate in the bank section (the right side of the reconciliation statement) the fact that bank should debit us (this is how the bank will cancel the erroneous credit that appears in Miles' accounts). In the right hand part (Miles accounts) there is no need to record anything as from the start, we (Miles) have not made any record at all concerning the $ 300.
Amounts that appear only in our accounts.
Check not yet presented- As at the date of reconciliation, the bank does not yet know that $ 160 is about to be deducted from our account. Had the bank known this, it would have debited us with this amount (debit, reducing our credit balance). The last row - the adjusted balance of $ 1,040.
That is the real balance in our account today (and not $ 1,00 or $ 1,500 as appeared in the pre-reconciliation balances.
The adjusted - balance - $ 1,040 - must be the same in both sections of the reconciliation statement, If the amount does not agree, it proves that we have not found the cause of the lack of agreement.
Journal Entries as a result of the Reconciliation In our accounts (Miles' accounts) we have to make entries in the journal as a result of the amounts that appear on the right side of the Reconciliation Statement. The entries will be as follows: Debit Credit 1. Debit: Western Union current account Credit: Current 30.6.xx 2. Debit: Expenses for bank Income from Interest account interest 50 50
charges Credit: Western Union current 10 account Current Account Bank Charges - 30.6.xx 10
The Nominal Ledger, after the additional entries, will indeed, show a balance of $1,040 as follows: WESTERN UNION Debit Pre-reconciliation balance Interest 1,050 1,040 10 1,000 50 CURRENT ACCOUNT Credit
Bank Charges
10
Comment: In the above example, the causes for the lack of agreement were presented at the beginning of the exercise. In real life, they must be "extracted" by comparing our bookkeeping accounts with the bank statement we received. THE IMPORTANCE OF THE BANK RECONCILIATION
If the practice in your business is to reconcile the bank statement each month, your situation is relatively good. It is reasonable to assume that your bookkeeping is good. If, on the other hand, the last Bank Reconciliation is done in your business, let us assume, retrospectively for the last six months, you almost certainly have a problem. There is a reasonable chance that your Current Account in the bookkeeping system (as well as the rest of the system) is not up to date. Bookkeeping records
For your convenience, here are the journal entries that relate to 3 subjects that we will discuss at various points. The subjects are: Subject Salaries Income Tax Deduction at Source Value added tax
Salaries
As a general rule, two Journal Entries will suffice. The first - a reference to the net payment to employees (the figures are "extracted" directly from the payroll). The second - to take into consideration the existing employer's payments (the figures are "extracted" from relevant Income Tax and Social Security forms.
The Journal Entry is as follows: $ 1. Debit: Nathan Debit: Warren Debit: Bjorn Credit Bank current account 8.9.xx - Net Salary Payments 2. Debit: Salary expenses Debit: Employers' tax expense Debit: Social security expenses Credit: Nathan Credit: Warren Credit: Bjorn Credit: Income tax deductions Credit: Social Security deductions 15.9.xx - Salaries Entry 8/xx 3. Debit: Income tax deductions Debit: Social Security deductions Credit: Bank current account 15.9.xx - Payment of deductions, Salaries 3,278 ==== 4,180 152 412 855 1,290 1,133 850 _________ 616 4,744 ====== 850 616 ________ 1,466 1,466 ====== 1,466 ====== 4,744 ====== 833 1,290 1,330 3,278 3,278 ==== $
The Explanations for Journal Entry No. 2
a. Salary expenses - $ 4,180 The sum has been extracted from the payroll (the gross taxable total). b. Employers' tax expenses - $ 152 The sum has been taken directly from the relevant tax forms.
c. Social Security expenses This is the only amount in the Journal Entry that is not extracted from another source. This amount is arrived at using the following formula: $ Total due to Social Security (according to the relevant Social Security forms Less: Social Security deductions from employees (from the payroll data) The difference is the employer's contribution for Social Security 616
204
412 =======
Comment: The three debit accounts above are normal expenses accounts. Their final destination is, of course, in the Profit and Loss Statement.
d. Employees' Accounts (Nathan, Warren and Bjorn) These are normal personal accounts that are in credit at this stage, as the employees are eligible to be credited by the employer with their net salary.
e. Income Tax/Social Security Deductions There are normal personal accounts in respect of the Salaries for August xx. Both the institutions (Income Tax and Social Security) are entitled to be credited by the
employer
with
the
amounts
that
appear
in
their
relevant
forms.
Nominal Ledger Records The T accounts for the three above journal entries will look like this: Nathan Debit (1) 855 Current A/c Debit A/c Credit 855 (2) at A/c Credit 3,278 (2) 1,466 (3) Social S. Debit (2) 412 Expenses Income Deductions Social A/c Credit Tax Debit (3) 850 A/c Credit 850 (2) Deductions Bank Warren Debit (1) 1,290 Salaries Ex Debit (2) 4,180 A/c Credit Bjorn Debit A/c Credit 1,133 (2)
1,290 (2) (1) 1,133 penses A/c Credit
EmployersExpenses Tax Debit (2) 152 A/c Credit
Security A/c Debit (3) 616 Credit 616 (2)
Tax Deduction at Source
In general, 2 different bookkeeping accounts are needed: 1. The "Deductions at source from suppliers" Account - the account organizes the tax that was deducted from your suppliers or service providers as well as the tax paid to the tax authorities on the due date each month. 2. The tax deducted at source from customers. = the account organizes the tax deducted from you by your customers.
Records in the "Tax Deduction at Source from Suppliers" Account
Data : 1.4.xx - You paid $100 plus VAT of $15 for printing. You deducted tax at source at a rate of 20%. (115 x 20% = $ 23) 7.5.xx - You transferred a sum of $ 23 to the tax authorities.
Bookkeeping records Debit 1.4.xx 1. Office expenses Value added tax on inputs Bank current account tax deduction at source 115 100 15 92 23 115 Credit
7.5.xx 2
Tax deducted at source from suppliers Bank current account
23 23 23 === 23 ===
Visually, the accounts would look as follows: urce Deductions from at so suppliers Debit (1) 23 Credit 23 (1)
Office Debit
expenses VAT o Credit 100(1) Debit
n inputs Bank cur rent a/c Credit Debit Credit
15(1) (1)92
Take care as the "Deductions at source from suppliers" account is, in all ways, a personal credit and debit account. The card indicates the amount that the Income Tax is entitled to receive from you for tax you have deducted from suppliers. The balance of the account may be in credit (before you have transferred the deductions on the due date) or it may be at zero (after you have made the payment to the income tax) but it can never show a debit balance.
Records in the "Deductions at source from customers" account
Data: On 5.4.xx, you issued a tax invoice in the amount of $ 1,000 plus $ 150 value added tax. The payer deducted 20% ( $ 1,150 x 20% = $ 230). The cash balance was deposited directly into the Western Union Bank. The Bookkeeping records Debit 5.4.xx Western Union current account 920 Customer's deduction at source 230 Receipts VAT on transaction 1,150 1,000 150 1,150 Credit
Visually, the accounts will look as follows: Western Current Union Debit 920 A/c Credit Customer'sction at Inc dedu Debit source Debit Credit ome Credit 100 VAT on
transactions
Debit Credit 150
Take care as the "Deductions at source by customers" account is in all ways a personal debit and credit account. The account indicates the amount that the Income Tax owes you as a result of the fact that tax was deducted from you at source. The balance of the "deductions at source by customers" accounts may show zero if no tax was deducted from you, or it may show a debit but the account may never be in credit.
VALUE ADDED TAX (V.A.T.)
For the purposes of value added tax records, three bookkeeping accounts must be kept.
1. The VAT on inputs account. 2. The VAT on transactions account. 3. Debit and Credit VAT account. 1. The VAT on Inputs Account - This account will usually show a debit (the VAT authorities "owe" you money for the VAT you have paid and that are entitled to receive from them). 2. The VAT on Transactions Account - This account will usually show a credit (the VAT Authorities are "entitled" to receive the VAT from you that you have collected from them. The money is not yours and it is only temporarily in your possession until the due date for the payment of VAT.
3. The VAT Debit and Credit account. This is the account to which the 2 first accounts are posted. The account balance may show a credit, when the periodic report to the VAT is for a payment to be made, or it may show a debit when the periodic report shows that that money is to be returned. A simple example: 30.1.xx - The total purchases that you made amount to $ 1,000 plus $ 150 VAT on inputs. 30.1.xx - The total sales you made amount to $ 4,000 plus $ 600 VAT on transactions. 15.2.xx - You paid the balance to that VAT authorities that was owing to them.
The bookkeeping records will look as follows: Debit Credit 1. Purchases VAT on transactions Current account at bank (30.1.xx) Purchases recorded for January 1,000 150 1,150
2. Current account at bank Sales VAT on transactions (30.1.xx) Sales recorded for January
4,600 4,000 600
3. VAT on transactions VAT on inputs VAT debit and credit account (30.1.xx) Transfer of surplus to debit & credit account
600 150 450
4. VAT debit and credit account Current account at bank (15.2.xx)Payment of VAT reported for January
450 450
